An immediate annuity can provide a life-long stream of cash flow. However, buying an immediate annuity should not be an all-or-nothing decision.
Instead, you might put part of your retirement fund into an immediate annuity and keep some or all of the rest in equities. The income from the immediate annuity will enable you to ride out market downturns and increase your chances of realizing the long-term returns expected from stocks.
Suppose, for example, you retire at age 62 with a $500,000 portfolio. You decide to withdraw $22,500 (4.5 percent) from your portfolio in Year One. Subsequently, you will increase your portfolio withdrawals to keep pace with inflation. Depending on your asset allocation and future financial market returns, there is a substantial chance your portfolio will be entirely used up if you live past age 92.
To reduce this risk, you might take $125,000 (25 percent) or $250,000 (50 percent) from your portfolio and use it to buy an immediate annuity. The remaining $250,000 or $375,000 can remain invested in stocks. With this approach, you’re less likely to run out of money. Research has shown that such a withdrawal rate can be sustained with more certainty, for longer time periods, by adding an immediate annuity to your portfolio. By pooling some of your assets with those of other investors, you can reduce “longevity risk”–the chance that you’ll run out of money.